First Trust to launch smart beta AlphaDEX ETFs in Europe

First Trust Advisors, a leading provider of exchange-traded funds (ETFs), is expected to launch into Europe sometime early this year. First Trust is the eleventh largest ETF provider in the US, with over $9 billion in ETF assets under management, and is perhaps best known for its popular AlphaDEX range of products. It is this range that First Trust is believed to be preparing to roll out in Europe.

First Trust appears set to roll out an initial three ETFs in Europe.

The provider is understood to be planning to launch an initial three AlphaDEX ETFs in Europe, to be listed in London and Ireland, subject to regulatory approval.

First Trust currently offers some 39 AlphaDEX ETF in the US, all equity strategies, tracking a range of countries, regions, sectors, market-cap segments and styles. More than $4 billion is invested across these products.

The AlphaDEX range is part of a movement or concept known as “smart beta” or “alternative beta”. This concept has been gaining momentum lately as investors have become progressively more disillusioned with conventional active management at the same time as academic understanding of portfolio return attribution has increased.

Historically, portfolio returns were attributed to passive market exposure (equity risk premium), captured through a combination of conventional capitalisation-weighted indices and active portfolio management. More recently, however, investors increasingly understand that many return components that were once attributed to skill (“alpha”) should in fact be correctly attributed to sources of systematic return (“beta”), such as value, size, volatility, or momentum. Strategies which attempt to target these sources of systematic return are known as smart beta.

Smart beta products essentially combine the strengths and advantages of both active and passive approaches. They typically work by tracking transparent rules-based indices which weight constituents according to various quantitative measures based on security fundamentals (such as valuation or earnings growth) and/or technicals (such as momentum and volatility). This is in contrast to conventional passive funds which track traditional market-capitalisation-weighted indices.

In the case of First Trust, the AlphaDEX ETF range is based on a series of enhanced indices which adhere to a rules-based stock selection methodology designed to select stocks from a set investment universe (parent index) that are attractive as measured by certain value and growth criteria. The indices aim to deliver higher long-term returns and lower volatility than their market cap-weighted parent indices.

To demonstrate, the index underlying the NYSE Arca-listed First Trust United Kingdom AlphaDEX ETF (FKU) – a possible candidate for the UK/European launch – ranks the eligible stocks from the S&P United Kingdom BMI (its investable universe) on growth factors including 3-, 6- and 12-month price appreciation, sales-to-price ratio and one year sales growth, and separately on value factors including book value-to-price ratio, cashflow-to-price ratio and return on assets.

The stocks are then given a score based on their growth and value rankings. The top 75 stocks with the highest score comprise the selected stocks. The selected stocks are then divided into quintiles based on their rankings and the top ranked quintiles receive a higher weight within the index. The stocks are equally-weighted within each quintile subject to a series of index constraints, such as a cap of 15% above benchmark weight. The index is reconstituted and rebalanced semi-annually.

The performance of this fund has been strong. Over the past 12 months, it has returned 12.63% compared to 4.38% for the comparable iShares MSCI United Kingdom Index ETF (EWU). Similar strong relative performances can be seen across the AlphaDEX range, making the products appealing to private investors, wealth managers, financial advisers and fund managers alike.

First Trust’s European AlphaDEX ETFs will be launched under the UCITS IV directive and are expected to come with a total expense ratio in line with their US counterparts, at circa 0.85% pa. London-based LGBR Capital has been tapped to help distribute the funds.